California Pioneering Market-Based Climate Change Solutions

California is hardly the place that comes to mind when one thinks of effective political leadership. Most would probably label Sacramento as a more deserving home to budgetary gridlock and massive debt. But in terms of tackling climate change through market-based mechanisms, California has set a compelling example for the rest of the world.

California’s one-year-old cap-and-trade program is the largest of its kind in the US and the second largest in the world. It requires freely tradable allowances for certain businesses that annually emit more than 25,000 metric tons of carbon dioxide equivalent (CO2e). In fact, the California program has already been linked to that of Quebec, increasing market liquidity as well as opportunities for carbon offset projects.

One of the primary methods of achieving such lofty targets is cap-and-trade, with free credits doled out to large utilities and industrial facilities for the first 90 percent of their emissions — a percentage set to decline over time. The “excess” emissions over that year’s cap must usually be purchased from other private sector participants who emitted below their targets and thus possess leftover allowances.

Additionally, what is widely perceived in the ETS to be a profusion of cheap carbon offsets — approved (and tradable) reductions in GHG emissions made at a separate location — has been addressed. Only 8 percent of a business’s compliance obligation can be essentially outsourced by purchasing carbon offsets, meaning that the majority of emissions reduction in California will occur “at the source.” This will also keep the carbon price from depressing too much due to an overabundance of approved offset projects.

Carbon price depression has especially plagued the ETS. Up to half of EU-wide GHG emissions reduction can be made by purchasing offsets. While this allows more flexibility for European businesses, the net result has been a glut of carbon offsets, depressing the price of an EU carbon credit to, recently, $7.23 per ton (of CO2e). To put this in perspective, ETS credits peaked at $43.88 (€32) per ton eight years ago.

Unsurprisingly, AB 32 has been swamped by a litany of high-profile lawsuits from both the left and right, including a failed challenge from environmentalists attacking the standards of offset approval and a recent case filed by the California Chamber of Commerce claiming that the statute amounts to an illegal tax.

Nevertheless, what may ultimately convince governments around the world to follow suit is the sheer amount of revenue that can be gleaned from a cap-and-trade program.

Thus far, Sacramento has generated $1.5 billion in revenue from a total of six auctions of carbon allowances. This number is guaranteed to swell in the coming years as more and more large-scale emitters are covered by AB 32.